The Employee Ownership Update

Loren Rodgers

March 15, 2012

Employee Engagement Remains Dismal

A new survey by HR Solutions Inc. of more than 3.3 million employees in 2,400 U.S. companies found that just 29% of employees say they are "engaged," while 59% are "ambivalent," and 12% "actively disengaged." In our own surveys of employee-owners, we do not ask the questions this way, but engagement levels would be vastly higher.

Sixth Circuit Breaks with Other Courts on Moench Presumption

In Pfeil v. State Street Bank and Trust Co., No. 10-2302 (6th Cir. Feb. 22, 2012), the Sixth Circuit Court of Appeals broke with other circuit courts on the issue of when plan trustees deserve the presumption of prudence for investments in company stock (the "Moench presumption"). Other courts have ruled that if the plan is an ESOP, or is a 401(k) explicitly designed to invest in employer stock, then company stock is considered prudent unless the fiduciaries know or should have known that the company was in dire financial circumstances.

This case looked at the ESOP component of GM's 401(k) plan. Employees could purchase shares in the plan. They challenged the trustee of the plan for retaining it as an option. State Street asked for dismissal based on the prudence presumption, but the court said its standard, as set out in Kuper v. Iovenko, 66 F.3d 1447 (6th Cir. 1995), raises a higher bar, at least at the pleadings stage.

SEC Challenges Pre-IPO Trading in Secondary Markets

The Securities and Exchange Commission has signaled that it will be taking a close look at prices and practices for pre-IPO shares in secondary markets. It has brought charges against two firms, Felix Investments LLC and Facie Libre Management Associates, for hidden and unreasonable charges assessed in the purchase of Facebook shares. On March 14, SharesPost, one of the biggest secondary market makers, agreed to pay $800,000 to settle an SEC complaint to register as a broker-dealer.

Second Thoughts on Floor Price Protection?

In the NCEO's new issue brief Floor Price Protection in ESOP Transactions, ESOP experts describe various approaches and issues related to providing plan participants protection against the impact of debt on stock prices after a second-stage ESOP leveraged transaction. The practice is common, but Ed Renenger of Stevens & Lee Employee Benefits Group noted in an email to us that the IRS, at least informally, has raised some concerns. In response to a question at an IRS call-in on the determination letter prices, a question was asked about how the IRS felt about price protection in which the impact of the debt was not considered in valuing ESOP shares of the protected group. The IRS representative responded:

"Well, quite frankly, we don't like it. Now valuation is generally an operations issue and on the determination side, we're reviewing the plan to see that you've got plan provisions that are compliant with the law. Here you have a plan provision which says this is what we're going to do when we conduct a valuation. And the valuation that we're going to conduct is basically going to ignore a substantial factor that might influence or affect the fair market value of the underlying security...

"We don't like this for two reasons. One, you have a provision that is setting the plan up to perform a valuation that won't necessarily reflect true value. Number two, this is really a hypothetical future event that you're asking us to endorse at the time the submission is made. You're saying without regard to any debt that is incurred by the ESOP to the shareholder to a later purchase of the stock in a leverage transaction, that's talking about something that's going to happen in the future that you want us to basically approve today. We would say, "I don't think that's appropriate. We would have a problem with it."

As Renenger noted, this is not a statement of formal IRS policy, and it only applies to putting this language in the plan document as opposed to developing it as a practice outside the plan. Still, it does suggest the IRS could have concerns, albeit they have not to date challenged plans with this structure.